The Cantillon Effect + Bitcoin Halving

New Money Issue #4

NEW MONEY is a recap of the week in itcoin. Everything you need to know, right to the point. New Money, is published by Adam Pokornicky of DAIM Digital, a Registered Investment Advisor for itcoin and Digital Assets. Twitter: @callmethebear

For the vast majority, Bitcoin is a phenomenon that is difficult to understand. The concept of a private form of money that only exists in the digital world is often easily dismissed as some kind of magic internet money. Ironically, Bitcoiners embrace this geeky and whimsical characterization given to it by the media and its many detractors as the the network continues to “magically” grow and operate.

Now, with over a decade in existence and its price making higher lows along with its seven network effects growing exponentially, the narrative around what Bitcoin is has completely shifted. We are seeing Bitcoin go from “magical internet money” to every government, bank, corporation and institution attempting to leverage it or build a competing version for themselves. This revolutionary concept and the need for its success could hardly be greater today. One of the reasons: the Cantillon effect.

Cantillon Effect and Wealth Inequality

Wealth inequality is a well documented problem in the United States, and more broadly across the world. The United States exhibits wider disparities of wealth between the rich and poor than any other major developed nation. This rise in wealth inequality over the past 30 years has largely been a function of monetary policy fueling a series of asset price bubbles.

So how is it that the Fed and Congress, while attempting to throw money at everyone, disproportionately tends to aid certain narrow financial actors? Richard Cantillon was an economist in the 18th century who mainly wrote about money and how it is distributed around the economy.

The so-called Cantillon effect describes the uneven expansion of the amount of money. Under modern central banking however, money is created and injected into the economy through the credit route and first affects financial markets. Cantillon explained that the first ones to receive the newly created money see their incomes rise whereas the last ones to receive the newly created money see their purchasing power decline as consumer price inflation comes about.

In the case of a monetary expansion, the ones who profit from it are the ones who are close to the money. “Close to the money” in this case means everyone who can access the money right at the beginning, i.e. big companies, banks, hedge funds, ultra wealthy individuals, etc. They get loans and make investments. Prices then start to rise even though the rest of the population has not received any of the new money yet. Nonetheless, they have to pay the higher prices even though they have not profited from the increase in money at all. And they will never profit from it in the same way as the ones who received the money first. In sum, the purchasing power of those furthest away from the tap drops the most. Eventually the prices rise before the new money has arrived "below". The result is a redistribution from the poor to the rich.

Bitcoin Fixes This

Bitcoin offers another form of redistributed money distribution. Instead of a system in which the monopoly on the creation of money incumbent on central banks and "systemically important" banks are favored, Bitcoin money creation is the task of the market by way of nodes and miners which participate in the decentralized money creation process. Thus, the circulation of the supply of Bitcoin is the result of the market while the circulation of fiat money is the result of a monopolist and therefore prone to political preference of interest groups.

For Bitcoin, this gives anyone an equal opportunity to participate in mining of Bitcoin or acquiring it on the open market. Every market participant has the same proximity to money creation, which makes Bitcoin at this level to apolitical money and protects against the Cantillon effect.

Bitcoin Halving Event

As we’ve already talked about in previous issues of New Money, Bitcoin has a hard capped supply of 21 million units. This means there will only be 21 million Bitcoins to ever exist. Having a 21 million hard cap ensures that Bitcoin is a deflationary asset, as opposed to an inflationary one like Dollars and Euros that can be created out of thin air at any given moment by central bankers.

The method in which Bitcoin are created are called “Block Rewards’. Every 10 minutes miners use specialized mining equipment to solve cryptographically hard puzzles while picking up transactions and forming ‘blocks’ that get added to Bitcoin’s blockchain. This process is extremely resource intensive and costs a lot of money and energy to mine and earn Bitcoin. The resulting Block reward is designed to economically incentivize the miners to continuously participate in the mining process and ultimately secure the network.

After every 210,000 blocks, Bitcoin goes through a process called “halving.” This mechanism was integrated into the original software protocol by Satoshi Nakamoto. When the protocol reaches its next “halving,” event, it cuts the supply of new Bitcoins in half, halving the miner’s block production rewards, as well.

Here is a historical overview of Bitcoin halving schedule

  • 2009: Bitcoin mining rewards start at 50 BTC per block

  • Nov. 28, 2012: The first Bitcoin halving takes place reducing mining rewards from 50 BTC to 25 BTC

  • July 9, 2016:  Second halving event takes mining reward down from 25 BTC to 12.5 BTC

  • May 11, 2020: The third halving will see the reward fall from 12.5 BTC to 6.25 BTC.

So considering all this, if the miners depend on block rewards as a major source of income, how do they deal with the halving events? Well for one, the supply/demand equation states that given all else is equal, in a competitive market, the price of a particular product will vary until it reaches economic equilibrium, wherein the quantity demanded is equal to the quantity supplied. All else equal, if the supply is low and the demand is high, this should lead to an increase in the price of the asset/product.

Bitcoin halving is at the very core of the protocol. Think about it. Halving ensures that it retains its deflationary quality. This makes sure that it remains ideologically opposite to fiat currency, which is centrally-controlled and inflationary by nature.

As you can see in the chart below, each halving event is followed by a significant bull run over the course of the next year and half. It is our contention that this time will be no different and the halving event will likely signal the early stages of Bitcoin’s next strong bull run into 2021.

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